Dynegy abandons Enron deal

Enron shares rise in Europe on heavy volume

By

LisaSanders

HOUSTON (CBS.MW) -- Dynegy Corp. on Wednesday abandoned its plan to rescue Enron Corp. after Enron's credit ratings were cut to junk-bond status, raising the prospects of a bankruptcy filing for what was once the largest U.S. energy trader.

In trading before the U.S. open, Enron last hit 72 cents in euro trading in Frankfurt, up 11 cents from its close in New York. Volume was unusually strong at 300,000 shares.

"Enron's an option at this point," one London-based dealer said. "There are plenty of people who will get in at 70 cents, knowing that the downside is limited. It's purely speculative."

Wednesday, Enron shares
ENE, +0.00%
lost more than 80 percent of their value. The stock has collapsed from a 52-week high of almost $85 just 11 months ago.

The company lost around $2.6 billion worth of market capitalization from Tuesday to Wednesday.

The collapse of the deal sets the stage for Enron to either be rescued by its bank lenders or to file for Chapter 11 bankruptcy protection, which would allow it to continue operations while it sells off its assets. Analysts said confusion about the size and scope of Enron's problems, particularly in regard to its derivative operations, make it difficult to determine whether the company is better off being sold or filing for protection.

"Chapter 11 is not the worst of all worlds by any means," said John Olson, a Houston-based energy analyst. "The key to salvaging the business is the level of debtor-in-possession financing they can get to allow them to trade in some realistic fashion."

Close to 342 million Enron shares had changed hands Wednesday by the close, and the stock broke the all-time volume record of 309 million shares set by Intel on Sept. 22, 2000. Dynegy
DYN, -0.24%
shares lost $4.92, or 12 percent, to $35.97.

Saying in a conference call that it had to "protect" its shareholders, Dynegy announced it had terminated its agreement with Enron, citing "Enron's breaches of representations, warranties, covenants and agreements in the merger agreement, including the material adverse change provision."

Company-specific problems?

Dynegy Chairman and Chief Executive Chuck Watson said: "some of the best deals are the ones that don't get done."

"While it is regrettable to see a leading industry player in difficulties, this does not reflect a failure of the energy merchant business," he said.

Dynegy President and Chief Operating Officer Steve Bergstrom said that energy traders have had weeks to prepare for Enron's diminished role in the business and that the industry has suffered "no degradation," as he put it.

"There has been a clear flight to quality, and it's occurring as we speak," Bergstrom said. "Dynegydirect is a highly scalable platform."

Dynegydirect is a platform much like Enron's flagship EnronOnline, which it turned off Wednesday and which just a month ago was the largest online energy-trading platform, accounting for an average of $3 billion in trades a day.

Dynegy's trading exposure to Enron is $75 million, and the company is no longer trading with its embattled former merger partner and fellow Houston industrial giant, Bergstrom said.

"Dynegy's customer-based, asset-backed energy delivery network has been the driver of our 45 percent compounded annual growth rate for the past 16 years and will continue to provide us with earnings sustainability and future growth." Watson said.

As part of the deal, Dynegy had the option to keep Northern Natural Gas, Enron's highly valued natural-gas pipeline, even if the agreement were terminated. The company said during the call that it would exercise that option.

ChevronTexaco
CVX, +0.11%
which owns a 27 percent stake in Dynegy, originally gave $1.5 billion to the company in the transaction. Dynegy used the money to purchase 100 percent of the preferred shares of Northern Natural Gas.

Enron has 180 days from the date the merger agreement was signed, Nov. 9, to repurchase the pipeline system, Watson said. Enron said in a statement that it was reviewing Dynegy's claim of rights to Northern.

Enron representatives did not participate in the call, and Dynegy executives said they had been advised against the customary practice of taking questions.

Enron said it has temporarily suspended payments "other than those necessary to maintain" its core energy businesses and added that it is exploring options to keep those operations alive. "To do this, we will work to retain the employees necessary to the continuing operations of our trading and other core energy businesses," said Enron Chairman and CEO Ken Lay.

Senior managers told employees that they would almost certainly be paid this week, although whether the company can make payroll on Dec. 15 is still up in the air. Filing for bankruptcy protection is a leading option, although the company hasn't yet set a timeline for any filing, they were told. One possibility was that Enron's core assets could be taken over by a bank, though no names were mentioned.

In a note to clients, analyst Michael Heim of A.G. Edwards said that Enron, without Dynegy, has "no value."

"Enron ... will most likely be declared bankrupt shortly," Heim said. "Unlike other bankruptcies in which a stock continues to trade at a low price, there are no hard assets to salvage."

Ahead of this news, S&P cut Enron's rating to B-minus, or junk status, from BBB-minus, which is the lowest investment-grade rating. The rating agency said that the move reflects "concerns about the viability of the merger agreement with Dynegy and liquidity implications of the possible failure of that transaction. The ratings are placed on CreditWatch with developing implications."

Moody's made its announcement of a rating cut to B2 from Baa3 and said that Enron's debt remains under review for additional downgrade.

In its report, Moody's cited the likelihood of a Dynegy-Enron breakup, fueled by Enron's declining financial performance, as the reason for the downgrade.

"Moody's ... Baa3 rating was predicated on good prospects for completion of the merger with Dynegy and reasonable prospects for marginally investment-grade characteristics of the merged entity," Moody's wrote. "Furthermore, lack of confidence in Enron by its trading counterparties appears to be adversely affecting Enron's core trading operations."

For Enron to survive, the credit agency said, it's imperative that the volumes from the trading business remain profitable.

Fitch, which had rated Enron BBB-minus, lowered the rating to CC, which "indicates that default of some kind appears probable."

The U.S. Treasury is keeping an eye on the impact the Enron fallout is having on the credit markets, spokeswoman Michele Davis said Wednesday.

"We are monitoring credit markets as we do every day," Davis said. "Markets always fluctuate and we haven't seen anything extraordinary." Treasury said that outside its surveillance of credit markets, it would refer any inquiries on energy trading to the Federal Energy Regulatory Commission or the Commodity Futures Trading Commission.

Earlier in the day

Dynegy, which had originally offered to buy Enron for $9 billion in stock, confirmed Tuesday that the two companies were discussing a new deal structure, and it said ahead of the credit-ratings and eventual termination news Wednesday that discussions were continuing.

"I'm not aware of any changes in any status of the merger," Dynegy spokesman John Sousa said before the S&P announcement. The merger agreement contained a material adverse-affect clause that, if triggered, allowed Dynegy to walk away from the deal.

The decline in Enron's stock price and information contained in the company's 10-Q filing of Nov. 19 could had activated the clause, but Olson said the S&P downgrade clearly fit the description of a material adverse affect.

Also Wednesday, UBS Warburg and RBC Capital cut their ratings on Enron, to "hold" from "strong buy" and from "strong buy" to "buy-speculative," respectively.

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